What is a flexible rate mortgage?

There are a wealth of mortgage products and different types of mortgages in the UK. In our previous mortgage guide, we provided a basic introduction to the differing types of mortgages based on interest rates . In this article, we explore the more popular flexible mortgages in more detail and also review different mortgage application approaches taken to provide the maximum mortgage borrowing under Financial Conduct Authority (FCA) legislation.

Flexible mortgages

When selecting a mortgage, most borrowers aim for a product that provides a fusion of high flexibility and low interest rates though typically one factor comes at the cost of the other. Some examples of flexibility include allowing mortgage overpayments and/or payment holidays. Elements of flexibility may be included in the standard mortgage product offered by the mortgage lender at thier standard interest rates. At other times, you will have to pay a higher interest rate to get a particular flexibility of your choice. To avoid paying extra interest, you should make a list of flexible features that are really essential and eliminate the ones that are unnecessary.

As a simple gauge: The greater the flexibility the Higher the interest Rate

Flexibility 1: Mortgage Overpayments

This is the most important flexibility in a mortgage. What this means is the mortgage should allow you to repay more than the monthly repayment -- either a small amount every month or lump sum payments at regular intervals.

Example 1: Let's say you have taken a new mortgage of £150,000 for 25 years at an interest rate of 5 years. Suppose you make a one-time lump sum payment of £25,000 in the month of August 2015. This early repayment can save you £45,961 in interest over the lifetime of the mortgage. Also, you will be repaying the mortgage 6 years and 9 months before the term of 25 years.

Most mortgage products allow some overpayment without any extra costs. But, they usually set a limit on the amount that can be overpaid. If you exceed the limit, you will have to pay an early repayment charge.

Mortgage Borrow-back facility

Along with overpayment, some lenders will allow borrowing back your overpayments if you need it. This feature can be useful for those who do not repay their mortgage out of fear of future emergencies.

Example 2: Nationwide provides a borrow-back facility on some of its mortgage products. If you overpay, the outstanding balance is reduced, and also the monthly repayments come down. Subsequently, if you borrow back some amount, interest is charged on the total borrowed amount (including the amount borrowed back), and this will increase the monthly repayments.

Flexibility 2: Mortgage Payment holidays

As the name suggests, the lender will allow you to stop your monthly repayments, if you want, for a certain period. However, there are conditions attached to such payment holidays. For example, some lenders will ask you to overpay a certain amount and then take a payment holiday. This way the payment holiday will be equivalent to a borrow-back facility.

At other times, lenders will continue to add interest to your loan during the holiday period. This would mean that the lender will allow you to miss a few repayments, but will recalculate your future monthly repayments to include the cost of the missed repayments.

Example 3: Virgin Money provides a payment holiday of 1 month if you regularly make nine monthly payments without any break. However, they will continue to charge interest during the payment holiday. Also, the payment holiday will increase your outstanding loan amount and thus will increase the future monthly repayments.

Some lenders may charge a fee for a payment holiday. For example, Santander charges a £60 fee for a payment holiday.

Both Virgin and Santander perform credit reference checks on borrowers before providing a payment holiday. The credit checks are to ensure that the borrower can afford the increased monthly repayments.

Note that even if your mortgage allows you to take a payment holiday, you cannot take one at your will. You need to discuss this with your lender first because otherwise it may look like a missed repayment and can affect your credit score.

Flexibility 3: Offset mortgages

These type of mortgages provide a lot of flexibility as you can use your savings to reduce the interest on your mortgage repayments. With an offset mortgage, you keep your savings with the same bank or building society that's offering you a mortgage. And you pay interest only on the difference between your mortgage amount and the balance amount in your savings account.

Let's say you have taken an offset mortgage of £250,000, and you have savings of £50,000 in your account. With such an arrangement, you will have to pay interest only on £200,000 (£250,000 - £50,000).

Note, there will be no difference in your monthly repayment amount as opposed to a standard mortgage. However, your monthly repayment amount will comprise less of interest and more of the principal, and thus will help in clearing off your mortgage faster. This can reduce the overall cost of your mortgage.

Offset mortgage also provides interest benefits. If you get interest from a savings account, such income is taxable, which means you get a lesser net interest after deducting tax. But if you offset those savings against a mortgage, you don't have to pay any tax on the interest benefit. Also, you will benefit from a higher rate because typically your mortgage interest rate will be higher than the rate offered on savings account.

Example 5: Let's say you have a mortgage of £125,000, and you have put £50,000 in your savings account and offset it against your mortgage. You are paying interest at a rate of 5% on your offset mortgage. Suppose you have to use the £50,000 as an offset against your mortgage for a period of 2 years. With an offset, you will be paying a total interest of £7,102 over 2 years, and you will not earn any interest on our savings.

Suppose you take a normal mortgage of £125,000 at an interest rate of 5%. And you do not use the amount of £50,000 as an offset; instead you keep this money in a savings account, which will pay interest at 3% for two years. In a normal mortgage, you will pay an interest of £12,349 over two years. And your savings account will earn interest of £2,429. This means your net interest cost will be £9,920 (£12,349 - £2,429) over a two-year period.

As you can see, an offset mortgage provides you with interest savings of £2,818 (£9,920 - £7,102).

While offsetting sounds like a real cool idea, in reality banks don't make things so easy for borrowers. Typically, lenders charge a higher rate of interest on offsets as compared to standard mortgages.

So, you should go for an offset only if the overall deal is beneficial for you. As seen in the above example, if the offset mortgage is charging you interest at a similar rate as normal mortgages, you can benefit from it. However, you should check all the other terms and conditions to make sure the benefit is real.

Another form of an offset mortgage is a current account mortgage, where the mortgage and your savings are combined in a single current account. You pay interest on the amount owed in your current account. Usually, these mortgages cost more than offset mortgages.

Joint mortgages

In a joint mortgage, both borrowers have the joint liability for a debt. If there's a default in payments, the lender can pursue either both the borrowers or any one borrower. With a joint mortgage, borrowers can get a bigger loan amount as opposed to applying individually. Lenders provide mortgage of up to five times the combined income of all the co-borrowers.

You can take a mortgage in a single name, but this means you alone will be responsible for repaying the mortgage. Your spouse's income will not be taken into account, and this will reduce your borrowing capacity.

At the time of application, lenders may ask if there's anyone else living with you, who is above 17 years. If you have not included your partner in a mortgage, the lender will want to know the reason for exclusion.

Buying with friends or siblings

Nowadays, there's a new trend in which a few friends or siblings come together to purchase a property. A few lenders provide a joint mortgage to up to four borrowers. If four people come together, their combined salaries will make them eligible for a higher mortgage.

However, each of them is jointly and severally responsible for the mortgage. So if one of the partners is going through a bad financial phase for a while, it won't matter to the lender if others have paid their share of monthly repayments. The lender will chase all the borrowers. In fact, they are likely to put more pressure on the borrowers who are working and have a source of income as opposed to a borrower with financial difficulty.

Taking a mortgage jointly with friends or siblings is an important financial decision and should be given due consideration. For example, if one of the co-borrowers misses a monthly repayment, it can affect the credit rating of other borrowers. If at all you are going for a joint mortgage, you should draw a legal contract, which should include all worst-case scenarios and the responsibility of each borrower in all such scenarios.

Types of agreements in joint mortgages

In a joint mortgage, there are two types of agreements.

If a couple jointly owns a property, the most popular ownership method is referred as 'joint tenancy.' This method is ideal for people in stable relationships. Both the owners own an equal share in the property. And if one of the partners in a 'joint tenancy' dies, the surviving partner will become the full owner of the property. It is not possible to transfer an individual partner's share under a will. If at all a will is to be made, the entire property will have to be transferred.

Another way of a joint ownership is being a 'tenancy in common.' In this method, both partners own a specific portion of the property, let's say 50% each. If the partners split, or if one partner dies, there is clarity on the ownership ratio of each partner. This method is also useful, if one of the two partners is putting in a higher deposit as they can take a higher share. 'Tenancy in common' is ideal if friends or family (not couples) are coming together to buy a property.

Guarantor mortgages

If you cannot secure a mortgage on your own, either because you have insufficient earnings, or you don't meet the affordability criteria of the lender, you can opt for a guarantor mortgage. In such a mortgage, a guarantor will promise to settle your mortgage repayments if you cannot pay for any reason. The guarantor will have to sign a contract with the lender. However, you, and not the guarantor, will be the owner of the property.

Let's say a young girl has just started earning, and won't meet the affordability criteria of a mortgage lender. However, the girl wants to have a place of her own. In such a scenario, her parents can help her in getting a guarantor mortgage by becoming her guarantors.

If the girl fails to make her repayments, the lender has all the rights to pursue the guarantors. The lender can even make the guarantor sell their assets to recover the mortgage amount.

As you can understand, the guarantor is taking a huge risk, so it is important for them to understand this before signing any contracts. To avoid any future trouble, the lender will ask the guarantor to get independent legal advice prior to signing any such contract.

Example 6: Harpenden Building Society offers guarantor mortgages of between £25,000 and £1,000,000. They allow relatives or friends of borrowers to serve as a guarantor. However, they advise the guarantor to take independent legal advice before entering into such an arrangement.

It is not necessary for the guarantor to commit to a mortgage for the entire mortgage term. The guarantor can be free of their obligations once the lender is comfortable with the level of debt remaining. The lender and guarantor can even agree on a set period, say 5 years, for which the guarantee is valid.

In a few guarantor mortgages, the guarantor may be asked to deposit money in an account, and they won't be allowed to access this money for some time. This money serves as a security for the lender, so that even if the borrower doesn't repay, the lender can always access the money deposited by the guarantor.

Conclusion

Flexible mortgages are suitable for everybody, and all borrowers should try to get the flexibility features of their choice. Joint mortgages help a great deal in increasing the borrowing capacity of the borrowers. And guarantor mortgages are ideal for those who cannot afford a mortgage on their own, but can arrange for a guarantor.

Use our mortgage calculator to calculate the costs of a mortgage with different interest rates and loan terms.